Your step-by-step guide to understanding and implementing the highly technical accounting rules of the IFRS that apply to derivatives and structured finance.
Implementing IFRS Successfully for Structured Finance
Graeme Tosen, the manager for technical accounting at HBOS Treasury Services in London, has written a step-by-step guide to understanding and implementing the highly technical accounting rules of the International Financial Reporting Standards (IFRS) that apply to derivatives and structured finance. This is your complete guide to implementing IFRS successfully for derivatives, structured finance and securitisations!
In his new book, Graeme Tosen will:
answer your questions on the accounting standards for these products
provide solutions to overcome the most common obstacles
use practical examples to explain the more complex accounting issues
compare IFRS with US GAAP
The IFRS text is more than 2,000 pages of rules, regulations and guidance. At last there is a summarised edition of the relevant accounting concepts for finance practitioners. This new guide saves you time by focusing on derivatives and structured finance products.
An essential reference for every practitioner needing to interpret and apply the rules to derivatives, structured finance and securitisations.
"...a straight-forward and easy-to-understand approach... It is, in my view, a very welcome addition to any financial professional's desk." -Phil Hodkinson, Finance Director, HBOS plc
Contents overview (see Contents tab for a more detailed description):
Fair value and amortised cost accounting
Embedded derivatives
Hedge accounting
Derecognition of financial instruments
Offsetting financial assets and liabilities
Impairment of financial assets
Consolidation
The effects of foreign exchange
Provisions, contingent liabilities and contingent assets
Debt/equity classification
Financial guarantee contracts
Administration
Writing a technical opinion and accounting checklist
Key terms: IFRS, International Financial Reporting Standards, structured finance, derivatives, accounting for derivatives, accounting for structured finance, securitisations, securitizations, accounting for securitisations.
Table of Contents
Contents:
Foreword by Phil Hodkinson, Finance Director, HBOS plc
About the author
1. Introduction (including how to use the book) The background to this book Who should read this book? The structure of this book How to use this book
2. Fair value and amortised cost accounting Introduction Background to the accounting rules Day 1 profit of loss Definitions Additional points Main issues Assets at amortised cost or fair value? Held-for-trading assets Designated at fair value through profit or loss The fair value option Loans and receivables Held-to-maturity investments Available-for-sale Financial liabilities Determining the fair value Step 1: First determine if the instrument price can be obtained from an active market Bid, mid or ask Recent transaction price Components and whole Step 2: What if there is no active market? Equity instruments with no active market Frequently asked questions · What is the ‘near term’? · What is ‘a pattern of profit taking’? · What about new non-derivative products where they are not acquired or incurred for selling or repurchasing in the near term but the entity still wants to classify them as held-for-trading? · Are all legal derivatives also derivatives for accounting? · Are any derivatives not accounted for at fair value? · How are synthetic derivatives (offsetting loans) treated? · What is the EU carve-out? · Can a proportion of a liability/asset be designated as at fair value through profit or loss? · How will assets where the holder may not recover all of its initial investment be classified? · What happens when there is no definite maturity date with regards to effective interest rate? · What do you include in effective interest rate calculations? · What would form part of initial measurement at fair value? · Is fair value and original cost/transaction price always the same and if not, how is the difference accounted for? · Is there a difference between ‘more than insignificant’ and ‘significant’? · Are there any exceptions to the tainting rules? · Do you consider all scenarios when determining intent and ability? · How are the foreign exchange profits/losses treated? · Can assets be transferred into the AFS category? · Are there circumstances where liabilities would not be at amortised cost? · Which rate should be used in discount cash flow analysis? Summary comparison with US GAAP Practical implementation
3. Embedded derivatives Introduction Background to the accounting rules Definition Purpose of the rules Main issues When do you have to separate an embedded derivative? Measurement issues Non-options derivatives Embedded options When embedded must and may not be separated from the host Frequently asked questions · Is there a choice to separate the derivative and treat it as trading if you wanted to? · How are synthetic positions treated where the derivative is legally a separate contract? · Did the EU carve-out create problems for European entities? · Do you only assess for separation at the initial recognition date or throughout? Summary comparison with US GAAP
4. Hedge accounting Introduction Background to the accounting rules Definitions Main issues What can be hedged? What can not be hedged? What hedging instruments can and cannot be used? The hedging criteria What types of accounting hedges are there? Accounting for fair value hedges Fair value hedge accounting for a portfolio of interest rate risk What happens if you cease hedge accounting? Accounting for net investments in foreign operations The hedge effectiveness issue Frequently asked questions · Can an entity designate a hedge relationship retrospectively? · What does ‘highly effective’ mean? · When will exposures not affect profit or loss and therefore not be allowed for cash flow hedging? · When is something ‘highly probable’? · How should an entity assess hedge effectiveness and when should an entity do this assessment? · What is the ‘roll-over rule’? · Can you hedge equity issued in a currency that is not your functional currency? · Can you hedge future profits? Summary comparison with US GAAP Practical implementation
5. Derecognition of financial instruments Introduction Background to the accounting rules Main issues The derognition decision tree for assets Derecognition of a part of an asset What happens if an asset qualifies for derecognition? Issues surrounding continuing involvement Issues surrounding collateral Rules regarding financial liabilities Frequently asked questions · What happens first – consolidation rules or derecognition rules? · Are computations required to prove transfer of risks and rewards? · What is the effect on transfer of an option to buy the asset back at fair value? · Does the standard provide any examples of a transfer of risks and rewards of ownership? Summary comparison with US GAAP Practical implementation
6. Offsetting financial assets and liabilities Introduction Background to the accounting rules Main issues Frequently asked questions · Would synthetic instruments qualify for offsetting? · Could more than one party be involved in a legal arrangement that would allow for offsetting? Summary comparison with US GAAP Practical implementation
7. Impairment and uncollectibility of financial assets Introduction Background to the accounting rules Main issues Impairment Events and indicators of impairment Future events Individual versus collective impairment Calculating the impairment loss and accounting for it (and reversals) Financial assets carried at amoritised cost Financial instruments at cost Available-for-sale assets Frequently asked questions · What if there are no relevant observable data to support the impairment calculation? · What constitutes a prolonged decline in fair value below cost for an equity instrument? · What does ‘similar risk characteristics’ mean? · What if you do not have groups of assets with similar characteristics? · What rate should be used if the effective interest rate was modified during a previous period? · What if assets have a variable interest rate? · If fair value of an amortised cost accounted for asset is observable in the market, can this value be used to determine the impairment loss? Summary comparison with US GAAP Practical implementation
8. Consolidation Introduction Background to the accounting rules Main issues When do you have control? Where an entity has voting power Where an entity has no voting power Special purpose entity Control under Paragraph 10 of SIC 12 Control and the appendix to the interpretation How should the accounting be done in the separate (non-consolidated) financial statements? What accounting processes will be followed on consolidation? Frequently asked questions · How are potential voting rights taken into account? · Can SIC 12 override IAS 27 when assessing an SPE for consolidation purposes? Summary comparison with US GAAP Practical implementation
9. The effects of foreign exchange Introduction Background to the accounting rules Definitions Main issues Establishing your functional currency How to translate to functional currency Translation of foreign operations for consolidation purposes Summary comparison with US GAAP Practical implementation
10. Provisions, contingent liabilities and contingent assets Introduction Background to the accounting rules Definitions Provisions Main issues Criteria The present obligation Legal or constructive A present obligation from a past event Determining the amount to recognise Risks and uncertainties Discounting Future events influencing cash flows Sale or disposal of related assets Contingent liabilities and contingent assets Contingent liabilities Contingent assets Summary of proposed IASB changes Frequently asked questions · What about a published dividend policy? · Must the expectation be on the part of the same parties to whom the statement was addressed in the case of a specific current statement? · Can the timing between a past event and the recognition of an obligation be different? · Do you provide for the possibility of changes in the law? · When would decisions by the board of a company give rise to an obligation? Summary comparison with US GAAP Practical implementation
11. Debt or equity classification Introduction Background to the accounting rules Definition Main issues Ordinary shares Preference shares Own equity transactions Contingent settlement and settlement options Compound instruments Frequently asked questions · How do you account for convertible bonds issued in a foreign currency? · What if an entity reacquires its own equity instruments? · What are the effects on the consolidated financial statements? · What happens when a compound instrument is settled early? Summary comparison with US GAAP Practical implementation
12. Financial guarantee contracts Introduction Background to the accounting rules Definition Main issues Initial measurement Subsequent measurement Designated at fair value through profit or loss Benchmark rules for subsequent measurement of financial guarantee contracts The difference between financial guarantee contracts and credit derivatives Summary comparison with US GAAP Practical implementation
13. Writing a technical accounting opinion and accounting checklist Introduction Steps to consider Practical implementation Accounting checklist
14. Understanding the administration Different standard names Different sections of the standards and their authority SIC and IFRIC The Accounting Framework IFRS standards currently in issue Interpretations
Definitions
Appendix – Disclosure of financial instruments Introduction How to use the disclosure table Disclosure requirements in IAS 32 but not in IFRS 7
Summary
This book is largely aimed at structured finance, specialised funding and liquidity, and treasury specialists, as well as accountants in these fields. The book aims to extract from the two thousand or so pages of the accounting rules and regulations the essential parts that would be most relevant to structured deals and present the issues and solutions in a way that the practitioner can easily understand.
The book sets out a number of specific areas in accounting that could be relevant in a structured finance or specialised funding deal – especially where derivatives are involved.
It is designed to:
• help you identify the initial value of an asset or liability and determine whether to accrual account, fair value account or cost account for any asset or liability (Chapter 2); • show you how and when to apply the embedded derivative rules (Chapter 3); • show you how to eliminate income statement volatility (hedge accounting) (Chapter 4); • help you determine whether or not an asset can be removed from the balance sheet (Chapter 5); • show you how to combine specific assets and liabilities and show them as a net asset or net liability (Chapter 7); • help you understand consolidation accounting (Chapter 8); • help you understand the effects of foreign exchange (Chapter 9); • teach you about provision and contingencies (Chapter 10); • help you appreciate how capital instruments are treated by the issuer (Chapter 11); and • help you understand financial guarantee contracts (Chapter 12).
The book has been structured in such a way to help you navigate your way around as easily as possible. Most of the chapters are divided into seven main sections.
1. Introduction. This provides specific practical examples of situations (assets, liabilities, actions and so on) that might exist as part of the proposed transaction you are about to undertake and which will be dealt with in the chapter. When you have identified a similar type of situation in the proposed transaction, you are directed to read the appropriate section in the chapter for an understanding of the consequences. For ease of use, a quick reference table is included in each chapter showing you where to look within the chapter for information on your situation. 2. Background to the accounting rules. This section provides an overview of the most important accounting rules and principles relating to the topic and sets the stage for the rest of the chapter. 3. Main issues. In this section there is a more detailed drill-down into the specific issues that might be present in a transaction. It delves into specifics, often expanding on the background and highlighting how the rules set out in the background section should be practically applied. It is also in this section that specific exceptions will be highlighted. Where appropriate, this section has been subdivided for ease of use and reference purposes. 4. Frequently asked questions. The FAQs deal with smaller, specific issues that could be transaction-specific and would not usually be found in every deal. Some of the FAQs expand on matters raised in the main issues or background sections, while others provide an insight into some of the more frequent problems that have been highlighted in the market in recent times. 5. Summary comparison with US GAAP. The aim of this book is to provide IFRS-based practical guidance. The US GAAP section therefore does not go into detail on accounting under the US rules, but merely highlights the most significant differences. A US GAAP user can therefore identify whether a significant difference does exist and, if so, refer to the US GAAP rules to gain a better understanding of the difference. 6. Practical implementation. As this book is a practical guide, towards the end of certain chapters you will find practical examples that highlight a more complex issue or provide a better insight into the way the rules should be interpreted. The examples have all been designed to be easily understood. 7. Important references to IFRS. This section can be considered a ‘last resort’ section. If more detailed information is required, it refers you back to the original IASB standards including Application Guidance (AG), showing where in the accounting standards the specific issues are addressed.
Other features of the book include the following.
• A basic checklist in Chapter 13 (on writing a technical accounting opinion). This checklist is important because it also enables you to navigate your way around the book. • Throughout the text there are links (called ‘Linked references’) to other sections or chapters of the book. This is especially helpful as the accounting standards are intertwined and one standard often has an impact on another. • Specific references to the FAQ sections are made throughout each chapter. These are used where a question dealt with in the FAQ section has a specific bearing on the issue under discussion. This also allows you to ascertain when to use the FAQs to help you further and when it is not necessary.
Author Bio
About the author
Graeme Tosen is the manager for technical accounting at HBOS Treasury Services in London, and specialises in the accounting for structured finance and derivative transactions. He previously worked as a technical accountant for Aviva plc, financial manager at Gensec Bank in Johannesburg, in the Capital Markets and Treasury division of PricewaterhouseCoopers, and as a Lecturer in Accounting at the University of Pretoria.
Graeme is a member of both the South African Institute of Chartered Accountants and the Institute of Chartered Accountants of England and Wales and is a CFA (Chartered Financial Analyst) charter holder, as well as a member of the Global Association of Risk Professionals.
He holds a masters degree in accounting from the Rand Afrikaans University in Johannesburg, South Africa, where his thesis was on the impact of IAS 39 on e-treasuries. He has also published a number of articles for specialist magazines on accounting and risk management.
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